December 2004 NationalEconomicTrends Views expressed do not necessarily reflect official positions of the Federal Reserve System. Ringing In the New Year with an Investment Bust? R eal outlays by firms for nonresidential capital equipment and software (E&S) plunged 9 percent in 2001, a recession year; it was the largest decline since 1958 and the third largest since World War II. In an attempt to kick-start business investment, President Bush signed legislation in March 2002 that, among other things, allowed firms to immediately expense (depreciate) 30 per- cent of the cost of E&S purchased between September 10, 2001, and September 11, 2004, and put into service before January 2005. In subsequent tax legislation signed in May 2003, this partial expensing provision was raised to 50 percent and the purchase date was moved back to December 31, 2004. An increase in the depreciation allowance for capital goods increases the present value of the firm’s deductions for tax purposes, which, all else equal, lowers the cost of capital. Accordingly, when the partial expensing provision reverts to its original level on January 1, 2005, the present value of the depreciation deduction will be less—and the cost of capital will be higher—than what it was on December 31, 2004. Although other factors were also probably at work, the recent growth of investment expenditures suggests that firms responded to this incentive, albeit with a lag. From 2001:Q4 to 2003:Q1, real E&S invest- ment fell at about a 1 percent annual rate; however, in the second quarter of 2003, real E&S investment surged at an 11 percent annual rate and has since increased at a 14.5 percent annual rate through the third quarter of 2004. With the expiration of the partial expensing provision fast approaching, some forecasters believe that many firms still plan to shift a portion of their planned capital expenditures from 2005 into 2004. If these expenditures are significant, then we would expect to see an upsurge in business investment in the final quarter of 2004 and then a drop-off in the first quarter of 2005 (or later). Recent surveys compiled by the National Association of Business Economics and the Federal Reserve Bank of Philadelphia suggest that some firms have already shifted, or plan to shift, some of their capital outlays from 2005 into 2004. 1 In August, forecasters expected a much larger slowdown in the growth of business fixed investment (BFI), from about 11 percent in 2004:Q4 to 6.5 percent in 2005:Q1. 2 Since then, as seen in the table, forecasters have concluded that there will be both a smaller burst in investment spending in the fourth quarter and less of a lull in the first quarter. Even though forecasters repeatedly changed their assessment of the relative strength of investment spending in 2004:Q4 and 2005:Q1—as viewed by the difference between the projected growth rates of real BFI in 2004:Q4 and 2005:Q1—they do not foresee such a swing in real GDP growth. This pattern is consistent with the fact that business investment (about 10 percent of GDP) tends to be more volatile than total spending. Thus, while forecasters expect some slowing in BFI growth in early 2005, they do not expect an investment bust (or, hence, a markedly slower growth of real GDP) to ring in the New Year. —Kevin L. Kliesen 1 www.nabe.com/publib/indsum.htm; www.phil.frb.org/files/bos/bos0904.html. 2 Business fixed investment includes structures, in addition to equipment and software. This issue of National Economic Trends will be the final printed copy. Future issues will be available at research.stlouisfed.org/publications/net. Are Forecasters Projecting a First-Quarter Slowdown? Percent changes at annualized rates Real GDP growth Real BFI Forecast date 2004:Q3 2004:Q4 2005:Q1 2004:Q3 2004:Q4 2005:Q1 February 2004 3.9 4.1 3.6 10.4 11.0 8.8 May 2004 4.1 4.0 3.8 11.5 10.3 7.7 August 2004 3.5 4.0 3.8 9.9 10.9 6.5 November 2004 3.9(A) 3.7 3.4 12.9(A) 10.0 8.5 SOURCE: Survey of Professional Forecasters published by the Federal Reserve Bank of Philadelphia. (A): Actual.
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December 2004NationalEconomicTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
Ringing In the New Year with anInvestment Bust?
Real outlays by firms for nonresidential capitalequipment and software (E&S) plunged 9 percentin 2001, a recession year; it was the largest decline
since 1958 and the third largest since World War II. In anattempt to kick-start business investment, President Bushsigned legislation in March 2002 that, among other things,allowed firms to immediately expense (depreciate) 30 per-cent of the cost of E&S purchased between September 10,2001, and September 11, 2004, and put into servicebefore January 2005. In subsequent tax legislation signedin May 2003, this partial expensing provision was raisedto 50 percent and the purchase date was moved back toDecember 31, 2004.
An increase in the depreciation allowance for capitalgoods increases the present value of the firm’s deductionsfor tax purposes, which, all else equal, lowers the cost ofcapital. Accordingly, when the partial expensing provisionreverts to its original level on January 1, 2005, the presentvalue of the depreciation deduction will be less—andthe cost of capital will be higher—than what it was onDecember 31, 2004.
Although other factors were also probably at work, therecent growth of investment expendituressuggests that firms responded to thisincentive, albeit with a lag. From2001:Q4 to 2003:Q1, real E&S invest-ment fell at about a 1 percent annualrate; however, in the second quarter of2003, real E&S investment surged at an11 percent annual rate and has sinceincreased at a 14.5 percent annual ratethrough the third quarter of 2004.
With the expiration of the partialexpensing provision fast approaching,some forecasters believe that manyfirms still plan to shift a portion oftheir planned capital expenditures from2005 into 2004. If these expenditures
are significant, then we would expect to see an upsurgein business investment in the final quarter of 2004 andthen a drop-off in the first quarter of 2005 (or later).
Recent surveys compiled by the National Associationof Business Economics and the Federal Reserve Bank ofPhiladelphia suggest that some firms have already shifted,or plan to shift, some of their capital outlays from 2005into 2004.1 In August, forecasters expected a much largerslowdown in the growth of business fixed investment(BFI), from about 11 percent in 2004:Q4 to 6.5 percentin 2005:Q1.2 Since then, as seen in the table, forecastershave concluded that there will be both a smaller burst ininvestment spending in the fourth quarter and less of alull in the first quarter.
Even though forecasters repeatedly changed theirassessment of the relative strength of investment spendingin 2004:Q4 and 2005:Q1—as viewed by the differencebetween the projected growth rates of real BFI in 2004:Q4and 2005:Q1—they do not foresee such a swing in realGDP growth. This pattern is consistent with the fact thatbusiness investment (about 10 percent of GDP) tends to bemore volatile than total spending. Thus, while forecastersexpect some slowing in BFI growth in early 2005, theydo not expect an investment bust (or, hence, a markedlyslower growth of real GDP) to ring in the New Year.
—Kevin L. Kliesen1www.nabe.com/publib/indsum.htm; www.phil.frb.org/files/bos/bos0904.html.2Business fixed investment includes structures, in addition to equipment andsoftware.
This issue of National Economic Trends will be the final printed copy.Future issues will be available at research.stlouisfed.org/publications/net.
Are Forecasters Projecting a First-Quarter Slowdown?Percent changes at annualized rates
Real GDP growth Real BFI
Forecast date 2004:Q3 2004:Q4 2005:Q1 2004:Q3 2004:Q4 2005:Q1
February 2004 3.9 4.1 3.6 10.4 11.0 8.8
May 2004 4.1 4.0 3.8 11.5 10.3 7.7
August 2004 3.5 4.0 3.8 9.9 10.9 6.5
November 2004 3.9(A) 3.7 3.4 12.9(A) 10.0 8.5
SOURCE: Survey of Professional Forecasters published by the Federal ReserveBank of Philadelphia. (A): Actual.
Contents
Page
3 Economy at a Glance
4 Output and Growth
7 Interest Rates
8 Inflation and Prices
10 Labor Markets
12 Consumer Spending
14 Investment Spending
16 Government Revenues, Spending, and Debt
18 International Trade
20 Productivity and Profits
22 Quick Reference Tables
27 Notes and Sources
Conventions used in this publication:
1. Shaded areas indicate recessions, as determined by the National Bureau of Economic Research.
2. Percent change refers to simple percent changes. Percent change from year ago refers to the percent change from thesame month or quarter during the previous year. Compounded annual rate of change shows what the growth rate wouldbe over an entire year if the same simple percent change continued for four quarters or twelve months. The compoundedannual rate of change of x between the previous quarter t –1 and the current quarter t is: [(xt /xt – 1)4–1] × 100.For monthly data replace 4 with 12.
3. All data with significant seasonal patterns are adjusted accordingly, unless labeled NSA.
We welcome your comments addressed to:
Editor, National Economic TrendsResearch DivisionFederal Reserve Bank of St. LouisP.O. Box 442St. Louis, MO 63166-0442
National Economic Trends is published by the Research Division of the Federal Reserve Bank of St. Louis. Visit the Research Division’s website at research.stlouisfed.org/publications/net todownload the current version of this publication or register for e-mail notification updates. For more information on data in this publication, please visit research.stlouisfed.org/fred2 or call(314) 444-8573.
National Economic Trendsupdated through12/01/04
3Research DivisionFederal Reserve Bank of St. Louis
See the Notes section at the end of this publication for the Feb. 7, 2003, revisions to the Household Survey, and the June 6, 2003, revisions tothe Establishment Survey.
transactions involving existing assets; (2) NIPA outlays exclude governmentinvestment and include consumption of government capital, while unified budgetoutlays do the reverse; (3) NIPA accounts exclude Puerto Rico and U.S. terri-tories; and (4) various timing issues are handled differently. Outlays andReceipts are from the NIPAs, except as noted. Since 1977, the federal FiscalYear starts on October 1. Excluded agency debt was 0.6 percent of federaldebt at the end of fiscal 1997. Federal Debt Held by the Public includesholdings of the Federal Reserve System and excludes holdings of the socialsecurity and other federal trust funds. Federal grants in aid to state and localgovernments appear in both state and local receipts and federal outlays.
Pages 18, 19: The Trade Balance (shown on a balance of payments basis) isthe difference between exports and imports of goods (merchandise) and services.It is nearly identical in concept to the Net Exports component of GDP, but dif-fers slightly in accounting details. The Investment Income Balance equalsincome received from U.S.-owned assets in other countries minus incomepaid on foreign-owned assets in the U.S. The investment income balance isnearly identical in concept to the difference between gross national productand gross domestic product, but differs in accounting details. The CurrentAccount Balance is the trade balance plus the balance on investment incomeplus net unilateral transfers to the U.S. from other countries.
Pages 20, 21: Output per Hour (Y/H), Unit Labor Cost (C/Y), andCompensation per Hour (C/H) are indexes which approximately obey thefollowing relationship: %(Y/H) + %(C/Y) = %(C/H) with %() meaning percentchanges. Unit labor cost is shown on page 9. Real Compensation per Houruses the CPI to adjust for the effects of inflation. Nonfarm business accountedfor about 76 percent of the value of GDP in 1996, while nonfinancial corpora-tions accounted for about 54 percent. Inventory Valuation Adjustments (IVA)remove the effect of changes in the value of existing inventories from corpo-rate profits and proprietors’ income. (This change in value does not correspondto current production and therefore is not part of GDP). Capital ConsumptionAdjustments (CCAdj) increase profits and proprietors’ income by the differ-ence between estimates of economic depreciation and depreciation allowedby the tax code. Components of national income not shown are rental incomeof persons and net interest.
NOTE: Most measures of economic activity are now based on the 2002North American Industry Classification System (NAICS), which replaces the1987 Standard Industry Classification (SIC) system.
SourcesBureau of Economic Analysis (BEA), U.S. Dept. of Commerce
National income and product accounts, international trade and investmentdata (except by country), auto and light truck sales.
Census Bureau, U.S. Dept. of CommerceInventory-sales ratios, retail sales, capital goods orders, housing starts,exports and imports by country.
Bureau of Labor Statistics (BLS), U.S. Dept. of LaborAll employment-related data, employment cost index, consumer andproducer price indexes, unit labor cost, output per hour, compensationper hour, multifactor productivity.
United States Department of TreasuryUnified budget receipts, outlays, deficit, debt.
Federal Reserve BoardIndex of industrial production, treasury yields, exchange rates, capacityutilization, household debt.
The Survey Research Center, The University of MichiganConsumer sentiment index.
The Conference BoardHelp-wanted advertising index.
Organization for Economic Cooperation and Development (OECD)GDP for major trading partners (not available on FRED).
NotesPages 4, 5: Final Sales is gross domestic product (GDP) minus change inprivate inventories. Advance, Preliminary, and Final GDP Growth Ratesare released during the first, second, and third months of the following quarter.Changes result from incorporation of more complete information. Real GDPis measured in 2000 dollars. The ISM (formerly Purchasing Managers’) Indexis a weighted average of diffusion indexes for new orders, production, supplierdeliveries, inventories, and employment. Aggregate and Average WeeklyHours are paid hours of production and nonsupervisory employees. TheInventory-Sales Ratio uses nominal (current-dollar) inventory and sales data.
Page 6: For information on how to calculate the Contribution of a componentto the overall GDP growth rate, see the October 1999 issue of the Survey ofCurrent Business, p. 16. The sign is changed for Imports.
Page 7: Ten-year Treasury Yields are adjusted to constant maturity; three-month yields are secondary market averages. All rates used in the yield curvesare adjusted to constant maturity. The 30-year constant maturity series wasdiscontinued by the Treasury Department as of Feb. 18, 2002. Standard andPoor’s 500 Index with Reinvested Dividends shows the total return: capitalgains plus dividends.
Pages 8, 9: Oil (West Texas intermediate) and Natural Gas (Henry Hub) spotand futures prices are listed in the Wall Street Journal. Spot prices are monthlyaverages of daily prices; futures prices are usually taken from the last tradingday of the month. Consumer Price Index is for all urban consumers. TheConsumption Chain Price Index is the index associated with the personalconsumption expenditures component of GDP. The Employment Cost Index(ECI) covers private nonfarm employers. ECI Compensation refers to a fixedsample of jobs, while Compensation per Hour covers all workers in thenonfarm business sector in a given quarter. In both cases, compensation iswages and salaries plus benefits.
Pages 10, 11: Effective with the May 2003 Employment Situation, the estab-lishment survey data for employment, hours, and earnings have been convert-ed from the 1987 SIC system to the 2002 NAICS system. All publishedNAICS-based labor series have been revised back to at least 1990. For moreinformation see http://www.bls.gov/ces/. Nonfarm Payroll Employment iscounted in a survey of about 400,000 establishments (Current EmploymentSurvey). It excludes self-employed individuals and workers in private house-holds, but double-counts individuals with more than one job. The HouseholdSurvey (Current Population Survey) of about 60,000 households provides esti-mates of civilian employment, unemployment rate, labor force participationrate, and employment-population ratio. Population is civilian, noninstitutional,16 years and over. The 90 percent confidence intervals for the unemploymentrate (± 0.2 percentage points) and change in household survey employment(± 290,000) measure uncertainty due to sample size. Because the householdsurvey was changed in January 1994, data prior to this date are not strictlycomparable. The Bureau of Labor Statistics announced several revisions tothe Household Survey on Feb. 7, 2003, with the release of the January 2003data. For more information, see <www.bls.gov/cps/>.
Page 13: The Michigan Consumer Sentiment Index shows changes in asummary measure of consumers’ answers to five questions about their currentand expected financial situation, expectations about future economic conditions,and attitudes about making large purchases. The survey is based on a representa-tive sample of U.S. households.
Page 15: Gross Private Saving is the sum of personal saving, undistributedcorporate profits with IVA and CCAdj (see notes for pp. 18-19), and privatewage accruals less disbursements. Gross Government Saving is net govern-ment saving (surplus/deficit) plus consumption of fixed capital. Balance onCurrent Account (NIPA) is net capital transfer payments to the rest of theworld plus net lending or net borrowing (international trade and incomeflows).
Pages 16, 17: Government Consumption and Investment is current expendi-tures on goods and services, including capital consumption (depreciation) andgross investment, as reported in the NIPAs. The Unified Federal BudgetSurplus/Deficit differs from NIPA Basis in four main ways: (1) NIPA excludes
National Economic Trends
Research DivisionFederal Reserve Bank of St. Louis 27